Federal Reserve leads central bank injection of billions

Central banks pumped tens of billions of dollars into money markets again as analysts used dramatic terms to describe distress in the international bank-lending system.

A huge symbol of the Euro in front of the European Central Bank in FrankfurtPhoto: AFP

By Jamie Dunkley

3:05PM BST 26 Sep 2008

"Apocalyptic" and "money market meltdown" were phrases used to describe the distress at the heart of the financial system - the interbank market where banks lend to each other.

After a US debt-rescue deal stalled overnight, the US Federal Reserve moved rapidly this morning with the European and Swiss central banks to deliver a further $13bn (£7bn) into crippled money markets.

Commercial banks usually seek extra funds at the end of each quarter, but credit has all but dried up as banks demand higher interest for the loans they make to each other as fear that another lender may collapse stalks the market.

"The problem is neither a lack of liquidity nor a question of the level of interest rates," said Stephane Deo, an economist at UBS. "It is essentially a problem of trust between banks."

Instead of lending money to each other over periods of a week or more, banks now focus on the short-term. "This is a sign [that] the lack of confidence in the system has reached extreme levels," Mr Deo said.

The Bank of England, which has been criticised by some for not moving quickly to assist banks, also said that from Monday it will hold auctions for three-month loans, starting with £40bn.

John Wraith of Royal Bank of Canada said: "The BoE's action should take some heat out of the situation."

The three-month London interbank offered rate, or Libor, soared yesterday by the most in almost a decade - an indication of tight lending conditions. Libor did ease marginally today to 6.2550pc, although the equivalent rate in Europe did widen to 5.1387pc.

Mr Wraith said that effectiveness of the BoE's action is likely to be limited because it is maintaining a strict list of the collateral it will accept in return for the loans. The BoE only accepts the Government bonds from G-10 countries and AAA+, top-rated debt.

The central banks used the reciprocal currency arrangements – or swaps – with the Fed to keep eurozone money markets primed as banks closed out their third-quarter books. Under separate techniques, the Bank of England provided $30bn for a week, and the South Korean central bank said it would inject at least $10bn.

The latest injection brings the total number of central bank "swap" deals to make dollars available outside the US to $290bn.

Fears that a massive US plan to bailout the financial sector might be delayed or watered down "have exacerbated money market tensions even beyond the extreme levels touched a week ago when the mood in financial markets was apocalyptical," said Marco Annunziata, an economist at UniCredit Markets.